Corporate Finance Complete Summary + Example Exercises (MBA BP - 2021)
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Course
Corporate Finance
Institution
Katholieke Universiteit Leuven (KU Leuven)
A complete summary of all the content covered in the Corporate Finance class of the MBA Bridging Programme for the exam in 2021. Contains additional comments and explanations given by the lecturer that aren't in the slides, alongside some example exercises and questions.
Used to prepare for the ...
,Table of contents
Part 1: Value
Table of contents ............................................................................................................................................................ 1
Chapter zero: concept of valuation ................................................................................................................................ 5
0.1. The concept of financial value ............................................................................................................................. 5
0.2. trick-questions to approach any valuation exercise ............................................................................................. 5
Chapter one : introduction to corporate finance ............................................................................................................ 5
1.1. Corporate finance decisions............................................................................................................................ 5
1.2. Role of the financial manager .............................................................................................................................. 6
1.3. Which decisions matter most?............................................................................................................................. 6
M&M1: Capital structure-irrelevance proposition (add full name) ........................................................................ 6
1.4. Agency theory in corporate finance ..................................................................................................................... 7
Agency conflict........................................................................................................................................................ 8
Corporate governance solutions ............................................................................................................................. 8
Chapter two: How to calculate present values ............................................................................................................... 8
2.1. Time value of money............................................................................................................................................ 8
2.2. Compound interest .............................................................................................................................................. 8
2.3. Multiple discount periods .................................................................................................................................... 9
2.4. Formulae for future values and present values ................................................................................................... 9
Compound interest ................................................................................................................................................. 9
Multiple discount periods ....................................................................................................................................... 9
Present value of a stream of cash flows.................................................................................................................. 9
2.5. Accommodation for changing interest rates ........................................................................................................ 9
2.6. Special cash flow streams annuities and perpetuities ....................................................................................... 10
Annuity ................................................................................................................................................................. 10
Perpetuity ............................................................................................................................................................. 10
Relation annuity-perpetuity .................................................................................................................................. 11
Chapter three : Valuing bonds ...................................................................................................................................... 11
3.1 Global bond markets (background) .................................................................................................................... 11
3.2 Terminology ........................................................................................................................................................ 11
YTM reflects opportunity cost of bondholders ..................................................................................................... 12
Issuers ................................................................................................................................................................... 12
Modalities ............................................................................................................................................................. 12
3.3 Bond risks and ratings ......................................................................................................................................... 13
Bond risks ............................................................................................................................................................. 13
Bond ratings .......................................................................................................................................................... 13
3.4 Valuing a bond .................................................................................................................................................... 13
Duration or ‘Macaulay duration’ .......................................................................................................................... 13
Volatility % or ‘modified duration’........................................................................................................................ 14
, Drivers of volatility ................................................................................................................................................ 14
3.5 Interest rates and inflation ................................................................................................................................. 15
Chapter four : Valuing stocks ........................................................................................................................................ 15
4.1 Terminology ........................................................................................................................................................ 15
4.2 Stock market volatility ........................................................................................................................................ 16
4.3 DDM-model for valuing stocks ............................................................................................................................ 16
DDM: one-period setting ...................................................................................................................................... 16
DDM: multi-period setting .................................................................................................................................... 17
Special DDM cases ................................................................................................................................................ 17
4.4 Business valuation in practice ............................................................................................................................. 18
4.5 DCF-models (as an illustration, just theory no exs) ............................................................................................. 19
Chapter five : Investment decision tools ...................................................................................................................... 19
5.1 Investment decision tools ................................................................................................................................... 20
5.2 Rules of thumb .................................................................................................................................................... 20
1: Book rate of return ........................................................................................................................................... 20
2: Break-even analysis .......................................................................................................................................... 21
3 & 4: payback and discounted payback period.................................................................................................... 21
5.3 Value creating rule: NPV of a company project .................................................................................................. 21
5.4 A note on IRR/ROR .............................................................................................................................................. 21
5.5 Analyses based on NPV ....................................................................................................................................... 22
Rationed capital analysis....................................................................................................................................... 22
Equivalent annual cash flow analysis (EAC) .......................................................................................................... 22
Chapter six : Investments in practice ............................................................................................................................ 23
6.1 How to obtain the project’s free cash flows? ..................................................................................................... 23
6.2 Real world examples ........................................................................................................................................... 23
IM&C’s fertilizer project ........................................................................................................................................ 23
Investment project by United Pigpen (UPP) ......................................................................................................... 25
Make of buy decision ............................................................................................................................................ 25
Part 2: risk
Chapter seven : Measuring risk and return................................................................................................................... 26
7.1. Value and risk..................................................................................................................................................... 26
7.2. Return of a single security.................................................................................................................................. 26
7.3. Risk of a single security ...................................................................................................................................... 26
7.4. Return of a portfolio of securities ...................................................................................................................... 26
7.5. Risk of a portfolio of securities ........................................................................................................................... 27
Diversification ....................................................................................................................................................... 27
Types of risk .......................................................................................................................................................... 27
7.6. Beta of a single security ..................................................................................................................................... 27
Estimation in practice ........................................................................................................................................... 28
, 7.7. Beta of a portfolio .............................................................................................................................................. 28
7.8. Risk-adjusted returns: SHARPE-ratio .................................................................................................................. 28
Chapter eight : Portfolio theory and the CAPM ............................................................................................................ 29
8.1. Markowitz portfolio theory ................................................................................................................................ 29
8.2. Efficient frontier ................................................................................................................................................. 30
8.3. Equations ........................................................................................................................................................... 31
Equation 1: Capital market line ............................................................................................................................. 31
Equation 2: Securities market line ........................................................................................................................ 32
8.4. CML and SML summary ..................................................................................................................................... 32
8.5. Testing the CAPM............................................................................................................................................... 32
8.6. Arbitrage Pricing Theory (Ross) .......................................................................................................................... 33
8.7. Fama-French three factor model ....................................................................................................................... 33
Chapter nine : Risk and the cost of capital .................................................................................................................... 33
9.1. Cost equity: Opp. cost estimate individual shareholder .................................................................................... 33
9.2. WACC: Opp. cost estimate company as a whole ................................................................................................ 33
Managing your WACC ........................................................................................................................................... 34
Estimating and improving the WACC .................................................................................................................... 34
Capita Selecta
Chapter ten : Options ................................................................................................................................................... 35
10.1. Financial options .............................................................................................................................................. 35
Call options: the right to buy ................................................................................................................................ 35
Put options: the right to sell ................................................................................................................................. 36
10.2. Valuing financial options .................................................................................................................................. 36
10.3. ‘Real options’ ................................................................................................................................................... 36
10.4. Analytical tool: decision tree analysis .............................................................................................................. 37
Example ................................................................................................................................................................ 37
Corporate investment context example ............................................................................................................... 38
10.5. Tips and tricks for managers ............................................................................................................................ 39
Chapter eleven : Market efficiency ............................................................................................................................... 39
11.1. Efficient market hypothesis (EMH) .................................................................................................................. 39
Simple logic, huge discussions .............................................................................................................................. 40
Consensus? ........................................................................................................................................................... 40
11.2. Upcoming interesting alternatives ................................................................................................................... 41
Chapter twelve : Debt policy ........................................................................................................................................ 41
12.1. Which decision matters most? Inv. vs. fin. decisions ....................................................................................... 41
12.2. Leverage (M&M2) ............................................................................................................................................ 41
Example ................................................................................................................................................................ 41
12.3. Two competing capital structure theories ....................................................................................................... 42
Trade-off theory.................................................................................................................................................... 42
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